son, Noreen, Brewer, 15e, Performance Measurement in Decentralized Organizations
ID: 2437689 • Letter: S
Question
son, Noreen, Brewer, 15e, Performance Measurement in Decentralized Organizations PROBLEM 11-18 Return on Investment (ROI) and Residual Income [L011-1, L011-2 "I know headquarters wants us to add that new product linc," said Dell Havasi, manager of Billings Company's Office Products Division. "But I want to see the numbers before I make any move. Our division's return on investment (ROID has led the company for three years, and I don't want any lctdown." Billings Company is a decentralized wholesaler with five autonomous divisions. The divi- sions are evaluated on the basis of ROI, with year-end bonuses given to the divisional managers who have the highest ROIs. Operating results for the company's Office Products Division for the most recent year are given below: Sales Variable expenses .. Contribution margin.... Fixed expenses . Net operating income.. Divisional operating assets $10.000,000 6,000,000 4,000,000 3.200,000 S 800,000 S 4,000,000 The company had an overall return on investment (ROl) of 15% last year (considering all divisions). The Office Products Division has an opportunity to add a new product line that would require an additional investment in opcrating assets of $1.000.000. The cost and revenuc character- istics of the new product line per year would be Sales Variable expenses.... Fixed expenses... $2,000,000 60% of sales $640,000Explanation / Answer
1) ROI for the most recent year = NOI / Divi Opera Assets = 800000 / 4000000 = 20% New Product line: Sales 2000000 Vari exp 1200000 Contribution 800000 Fixed exp 640000 NOI 160000 Operating assets 1000000 ROI for the New Product Line = NOI / Divi Opera Assets = 160000 / 1000000 = 16% 2) The last year's ROI had been 15%, so the new product line should be accepted with ROI of 16%. 3) The headquarters is anxious for the office products division to add the new product line, so that the ROI is improved since last year. 4) Residual income for most recent year = NOI - Minimum return = 800000 - (4m * 12%) = 320000 Residual income for new product line = NOI - Minimum return = 160000 - (1m * 12%) = 160000 - 120000 = $40000 Yes, Dell Havasi should accept the new product line being positive Residual income.
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